Sunday, June 17, 2018

Learning from the Demise of G-7 through the Battle of Cowpens - Weekly Blog # 528

I learn and apply these lessons to our investment tasks, communicating them through these blog posts. Global policy judgments are not a focus of these blogs. One can learn from watching conflict resolutions in military, political, and sports worlds that are useful in thinking about future investment decisions.

The G-7 meeting

The G-7 meeting in Canada was a wonderful display of tactics that may predict future strategic movements. President Trump was widely criticized before the meeting as a protectionist, particularly by European allies and Canada. In a brilliant flanking move, he surprised them at the meeting by suggesting a relationship with no tariffs or other barriers to trade. What it revealed was that each of the other countries involved had higher tariffs and more trade constraints than the US. The reason for the discomfort (or more correctly, horror) was that these were put into place to benefit specific politically powerful interests, which would presumably be hurt in a no-tariff world and would cause most of the governments at the meeting to fall. (The US is very conscious of the tariff wall which was the primary cause of the early conflict between the Northern and Southern states and thus really led to the Civil War.

The future may well depend on how close a parallel this is to the Battle of Cowpens during the Revolutionary War and its aftermath.

The Battle of Cowpens

The Battle of Cowpens, fought in 1781, was an engagement between American Colonial forces under Brigadier General Daniel Morgan and British forces under Sir Banastre Tarleton. Tarleton’s force of 1000 British in the King’s Army went up against the 2000 men under Morgan. Only 200 of the 1000 British troops escaped the battle. The Colonial forces conducted a double envelopment of Tarleton's forces.
From the American side, almost equally as important, they lost two major cannons that could have helped the Colonial forces at Yorktown.

Tarleton was a young and impetuous commander who marched tired troops into battle and fell into a well designed trap of counterattacking by the Americans. The Americans were instructed to fire two rounds and then retreat into the hills, sucking the tired troops into fire from three emplaced positions with their open flank. That is where the American cavalry showed up, having circled the British lines.

The battle was a turning point and coupled with the British defeat at King’s Mountain, compelled Cornwallis to pursue the main southern front of the American Army into North Carolina, leading to Cornwallis’s surrender at Yorktown. Quite possibly, if Cowpens had turned out differently, there might have been a British fleet off Yorktown rather than the French fleet and the US would have remained within the British Empire a little longer. Except, unknown to the participants, a peace treaty had already been signed in London, with considerable help from some members of Parliament.

Clearly the tactics at Cowpens may have had a role in the strategic reorientation of Britain and the United States. Could this also happen to the make-up of the G-7? Was the difficult meeting in Canada a part, perhaps a necessary part, of the pivot to Asia?

Investment Lessons

The following are possible parallels from the G-7/Cowpens actions:
Read more fully about the past and look for less popular, simplistic explanations.
Be careful about following young, impetuous leaders.
Early gains can be a trap.
Rest is an important ingredient for victory.
Don’t leave your flanks unguarded.

Follow-Up Bits

Everyday we are greeted with bits of information, rarely however do we get the complete picture. Often, the bits are in conflict with each other and formerly perceived “truths.” The following are listed in order of their published date.

Money Market deposit account interest rates jumped to 0.52% vs. 0.47% before the Fed raised rates by 25 basis points.

The American Association of Individual Investors (AAII) weekly survey turned roughly 5 percentage points more bullish, dropping 5 percentage points from the bearish category. [At this level, rising short-term interest rates are apparently viewed as bullish.]

Mutual fund investors around the world are primarily investing for long-tem needs, largely retirement. At the end of 2017, US investors owned 44.8% of the $49.3 trillion invested in Funds, with only 31% in equity funds. Of American households, 45% own Funds, with 61% owned in tax deferred accounts. Thus, conventional mutual funds are unlikely to be the leaders in the next speculative surge in the market.
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Sunday, June 10, 2018

When, Not If - Weekly Blog # 527

The Next Recession

Recently, two very senior operating officers of significant organizations asked for my outlook on the next recession. I am very sympathetic to their quest for guidance, as it will immediately impact their day to day decisions which are trending quite positive. Taking the advantage of being an interested observer without operating responsibilities, I replied with some certainty that a recession was on the way.

The real question was when, not if. To be honest, I don’t know. Predicting the timing of a recession with operating precision is similar to the task of identifying when a volcano on the Big Island in Hawaii will erupt, or when “The Big One” (massive earthquake) will hit. One of the techniques in the USMC is to identify the potential for trouble rather than exercise the arrogance of solely predicting.

Why am I confident that there will be a recession? Because throughout the history of humans there have been cycles of alternating relative calm and crises, with some of these being caused by changes in weather. In the world of markets and economies the main stimuli for cycles are human behavior. The causes usually start with the word “over”: Over-building, over-capacity, over-borrowing, over-hiring and other terms for over expansion, or if you will over-expansion.

In explaining the falling apple, Sir Isaac Newton identified the physical laws of gravity. He believed they and other physical phenomena were put in place by “The Watchmaker in the Sky,” or God.  Perhaps there is a similar force that periodically corrects for errors in human risk management behavior. Having established, at least for me, the certainty of periodic recessions, the more difficult task is predicting the timing. I must admit that I fall back to the lessons of both the race track and highly valued stock prices, plus the power of envy.

Most people individually are quite bright and make reasonable decisions. However, when we enter “the crowd” our innate insecurity draws us to popular views which become ours. These are then reinforced by something psychologists call “confirmation bias.” Substituting Newton’s watchmaker with an eternal “bookie,” the greater the power of the confirmation bias the greater the odds that it is wrong. Thus, as noted in last week’s blog, with the large, learned, financial institutions’ belief that the next recession is three to five years away, it is an intelligent bet to make against the crowd. (A much more difficult bet to make wisely is which side of the over/under challenge to accept. Right now the odds favor the next recession coming more quickly than in three to five years, but there have been very long streaks in history which could give the “over” bettors some comfort.)

Risks of Fraud and Mistakes

Thus far, I have just focused on the normal tug of war between greed and fear. There are two other indefinite variables. The first is the surfacing of a large fraud from a respected place. A careful study of humans reveals that at almost all times there is a level of fraud. Sometimes the fraud includes intellectual fraud along with criminal fraud. One of the characteristics of the period before a recession is the pace of activity accelerating and the public scramble for attaining wealth being top of mind. Thus, the time spent on careful underwriting risks is shortened and the envy for wealth is heightened.

The second variable is the frequency of mistakes. During these volatile periods small errors occur in transactions more frequently, caused by too little time and too little experience, by both buyers and sellers. This accelerated pace often leads to big mistakes by important people and major organizations. In the post-mortems after failures, the repeated question is often how these very bright, accomplished people could make these mistakes? The answer appears to be the rapidity of the times demanded it. 
Economic recessions and market cycles have been necessary to correct for human excesses. Thus, in the long-run they are cyclical in nature, but do not change secular trends.  Long-term portfolios should be diversified across both cyclical and secular patterns. A 50/50 balance between the two is a useful starting point in portfolio construction because it prevents over concentration on the intermediate and long-term investing.

Two Significant Pivots

1.  Tactical Pivot

This week’s fund performance displayed a significant change. Prior to last week there were a limited number of equity gainers concentrated around the production and use of cell phones. Globally, growth-focused funds were just about the only asset class to show gains. In the week ended June 7th there was a dramatic change. Value-oriented funds joined Growth funds in generating positive results year to date. Their gains in the week turned many of these funds to gainers for the year. The bigger turnarounds were experienced by Base Metal Commodity funds +4.85%, Basic Materials funds +3.41% and the already positive for the year Consumer Services funds +3.73%. One could interpret these results as an indication that a further cycle expansion became likelier last week.

2.  Strategic Pivot

For a considerable length of time mutual fund investors have been net buyers of non-domestic equity funds. This focus on non-domestic equity funds is clouded by the way the vast majority of international funds display their portfolios. Most funds rely on portfolio statements from their custodians. Where a corporation is legally domiciled is important to a custodian as a source of local law and taxation. This information is much less important to investors than where companies are making their sales and pre-tax operating profits. The mismatch is clearly seen when it appears that the majority of US foreign investment is in European entities. While this is legally true, it is not helpful as to where our foreign funds expect to make their money.

Most large companies are multinational in scope. This is particularly true of companies domiciled in the UK, Germany, Sweden, and the Netherlands. To the extent that these companies are showing growth it is coming largely from Asia. This makes sense on both demographic and savings trends. The leading middle class growing countries are China, India, and Indonesia. They have populations that are in the early stages of acquiring the goods and services that more developed countries produce, either at home or in their overseas facilities. This is the reason that we are investing for our clients in Asian-oriented funds for the long run.

Asian Play

This weekend we are seeing American political leadership following investors pivoting toward Asia, which is causing distress for many Europeans, even though they are also significant Asian investors. The Asian play is not geographically limited to the Asian continent. Latin America, Canada, Africa, and the Middle East are junior partners to the growing power bases in Asia.

Belmont Stakes Implications and Lessons

I look for useful implications from everything that happens as I’m always willing to learn, even if at times reluctantly. The running of the 150th Belmont Stakes, which was won by Justify with Gronkowski in second place, was just such a learning experience.


Did you notice the silks worn by the winning jockey or the crowded picture in the Winners Circle? The winning colors are those of one of the three syndicates that own Justify, the winner. They belong to the China Horse Club, a group of some 200 Chinese investors. I am guessing that an old friend and retired good investment manager was probably not surprised that this group was part of the winning combination. He recently pointed out that after a lifetime of collecting selective Chinese art, the prices for such pieces has skyrocketed as Chinese buyers attempt to repatriate their art by becoming the dominant buyers. I suspect we will see more Chinese money buying into racing and more importantly breeding opportunities to meet both nationalistic and long term investment needs. (One of the real power centers in Hong Kong is the Happy Valley Racetrack.)

The other two owners are equally interesting. WinStar Farms is another syndicate, whose leader has the corporate title of president, suggesting that it is being managed with more of a corporate philosophy than just the skills of a bunch of enthusiasts.

The third owner is perhaps the most interesting of all. It is the family office of the famous, or infamous depending on your political views, George Soros. Disregarding politics, the office’s investment approach is sound. It buys into some of the best thoroughbred breeding stock and regularly sells off many of the resultant yearlings, with advantageous tax benefits. Not surprisingly, the manager of this operation is the tax manager. This is one of the ways the wealthy, who want to remain rich, employ intelligent risk management techniques. In this case it sold off the racing earnings of Justify and retained the breeding rights. At this point the colt’s racing earnings, including the Belmont win, is $3.7 million. However, the ownership has sold off most of the breeding rights for $60 million.

The investment implication highlighted by Justify’s ownership structure is that the world is moving toward more professional management of assets and liabilities and away from pure family control.

The Betting Lesson

A reported 90,000 people were at the track on Saturday and many others bet largely through electronic means. As much as I scanned the entries, I could not find a substantial reason, other than racing luck, that Justify was not clearly the best horse in the race. However, my discipline would not let me make an odds-on bet where the amount won would be less than the amount wagered. (I do this in my investing portfolio when buying good long-term stocks.) The colt did win and paid off $3.60 for a $2.00 Win bet, or after returning the $2.00 bet realized a gain of $1.60. I am reasonably certain that this was not a good return for the risk of being wrong. If one considered the winning position for Justify and then selected the second best colt, one might have bet on Gronkowski for Place. In fact, he came in second from trailing behind until late in the race. One would have won $13.80 or a gain of $11.80 for a $2.00 bet, or over seven times more than the winner.

The critical investment lesson to learn: Picking winners is not as productive as balancing the risks and rewards of investing.
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Sunday, June 3, 2018

Facts Trap Us into Choices - Weekly Blog # 526


Why do very bright people make wrong choices? In our highly professional world of investments why do so many financially sophisticated investors choose the wrong investments at the wrong time and in the wrong amount?

I believe that I should always be learning. Because of my investment performance background I study smart investors who regularly make mistakes. Hopefully, I will learn to my clients and my own benefit. With the above mission in mind I was struck by an article entitled “In Defense of Ignorance” which was published in the Marathon Global Investment Review. Marathon Asset Management is a very thoughtful and successful investment manager based in London. Apparently its skillset is to focus on the supply side of economic equations and limit its input largely to facts about supply. As this focused approach has worked for Marathon and its clients, I considered this thinking in terms of my own intellectual process of transitioning from security analyst through various stages to becoming an entrepreneur and registered investment advisor.

Career Transition

As I was finishing my active duty in the US Marine Corps, my plan of action to feed my young family of three (and more planned) was to become a security analyst, study all there was to know about a leading company in an important industry and be hired by a company’s investor relations area as a person serving financial analysts. My career goal then was to be a junior officer of a large, stable, and hopefully growing company by retirement. Luckily for me it didn’t work out that way.

As an analyst my goal was to gather more facts than anyone else on a targeted company. Interestingly enough, the help of employers and analyst societies did not prepare me for the real commercial world. I had to learn, usually by observing, how to sell investment research, make sensible investment decisions, understand internal politics, seek clients, and learn how to run a business. Thus, I had to move away from the simple task of just gathering facts, as comfortable as that was, to a broader set of skills.

Analyst vs. Entrepreneur

Recently I have become convinced that much of the thinking processes of investment, business, and political leaders has evolved in a similar fashion. For a long time leadership was assigned to those who gathered the most facts. Many of them were like a good litigating attorney that gathers all the known facts about a case. He or she does not want to be surprised by something said by a favorable or opposition witness. After gathering the facts, attorneys are selective as to how they build their persuasive pitches. These types of leaders, often rising through highly structured organizations, are replaced or out-maneuvered by an executive decision-maker.

The rise of the executive decision-maker is changing our world as we know it. The old practice of following a case study of known procedures is giving away to more free-form decision-making. Increasingly, successful nations and business operators have less in common with their perceived competitors. 

It is not this blog’s mission to solve world and macro problems, but rather to focus on investments largely through investment managers and mutual funds. With that thought in mind I am wondering whether our practice of building diversified portfolios based on asset classes, size of companies, locations, and market capitalizations, which worked well in the past, is becoming outmoded. Should we assemble our managers and their funds as a good theatrical producer does with people of different talents? A good producer brings these multi-talented people together in a way that produces good results as a unit. As we move in that direction we will need a different classification system, which may be different for each client portfolio.

The only time I had some limited experience with this was when I was fencing in college. In a very short time I had to make a guess whether my opponent favored offense or defense, how to change the expected flow of events, how to lure an opponent into changing styles, etc. We know that most managers are reactive to prices or announcements, only some attempt to position prematurely. Others march to their own drummer and stay fixed in their actions regardless of other stimulants. As we have very intelligent readership of these blogs, I am wondering whether any have some guidance for me as I struggle to adapt to my perceived view of the new world of investing. Please contact me at

For the Fact Gatherers

Demand for money is gradually rising. In the daily Wall Street Journal there is a statistical box of ten “Consumer Rates and Returns to Investors.” These indicators go from short-term to 30 year mortgages. Each are shown at their current level and their range for the year. Four of the ten are near their annual highs and none are more than 51 basis points away from their annual high.

Two items:
  •  Merrill Lynch’s technical people view cyclicals as being more attractive than defensive stocks. They do not see a recession near term.
  • PIMCO’s latest view is that the next economic recession is 3-5 years way.

When these two major market movers (along with most others) express their views, as a contrarian I get worried about a surprise that blindsides the majority of the thinking. I would be particularly worried if the stock market goes to another new high this year.

There is likely going to be more excitement about the opening up of the Chinese “A” share market to foreigners. WisdomTree* is warning that many stocks do not have good characteristics as investments, so be careful.
*Personally owned.

All too often professionals utilize a formulaic process rather than adjusting to the changing environment.  This leads in many cases to some bad choices.
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Copyright © 2008 - 2018

A. Michael Lipper, CFA
All rights reserved
Contact author for limited redistribution permission.

Sunday, May 27, 2018

Investing Successfully – Weekly blog # 525


Investors often unconsciously think about their assets and investing. Our own actions, as well as those of others, create opportunities to add or subtract from our assets through opportunities or threats. Our sum total of assets in life is a culmination of our experiences, including thought patterns. For most of us, far too little of our time is spent on consciously thinking about how we invest our resources, emotions, energy, and financial assets. The purpose of this blog is to develop our investment thinking.

The first step is to take an inventory of how we spend our careers, emotions, energy and capital to further our goals, as undefined as they are. The second step is to begin the process of deploying our limited financial assets, beginning at its easiest least threatening level. (For almost all of us, our assets are more limited than what we want to accomplish with them.) The third step is to spend some time and energy on what I will label Capital Motivation.

Capital Motivation

Capital motivation, in an imperfect world with imperfect people, is to optimize not maximize how we focus our emotions, energy, and intelligence in deploying our financial and other assets. We need to begin a task that will never end, listing the threats and opportunities that are before us right now. How should we optimize our capital against each of the major opportunities and threats facing us? This sounds like an almost impossible task, but begins first with conversations both with ourselves and others to draw from our experience banks. Even the most financially knowledgeable institutions and individuals do not have all the answers. They are addressing their perceived needs as best they can and in many cases recognize the unanswered threats and opportunities that stretch out before them. In reality we are all sinners in this task.

What is Your Capital?

Those of us that invest in individual securities and funds recognize that fundamentally we invest in people. When analyzing any specific investment the single most important factor is the individual personality driving the investment in terms of the timing of inflows and outflows, as well as goals. Using a concept as old as The Bible, each of us are relatively short-term renters of the assets we currently command. Over time they become the temporary assets of others, known and unknown as well as those of the global society. This is why I believe any investment plan, self generated or produced by an adviser, needs to start with the individual decision maker and perhaps terminate with the welfare of the corporate and/or individual beneficiaries.

Our single biggest asset is our reputation for integrity, not only to others but also to ourselves. Eventually we need to deliver on our promises to ourselves as well as to others. In effect, when we promise we are creating a contract and we will be known for our ability to complete our contracts and in many ways the art of investing is dependent on our ability to live up to our contract. It is in this light we manage the mix of our financial and other assets on the continuum between capital appreciation and capital preservation.

Capital Appreciation 

Through accidents of life and our own hard work we have a pile of assets which most often come with some encumbrances. Part of the strings attached to our assets, plus a desire to grow them to meet future needs, is the continuous need to manage the appreciation of our assets. There is risk of loss in everything we do and the opportunity to appreciate assets itself comes with risk. On the surface, most of the time risks appear to be equal or exceed identified rewards. It is our skills, integrity, and energies, properly committed, that change the ratio of risk to reward. Outside of internally produced risks, there are two others.

As long as society promises to take care of those who don’t take care of themselves there will be taxes and they will be likely to be progressively higher on higher income. Perhaps the biggest reduction to the value of your investments is the inability of governments to compensate you completely for what they spend, as through their control of the creation and supply of money, they induce inflation. Inflation not only increases expenses, it lowers the value of our intellectual and financial assets. Over a family’s lifespan, inflation could be the biggest hurdle to meeting perceived goals.  These two societal payments also influence capital preservation. To overcome drags on our wealth we look to different capital appreciation approaches. While there may be some income element in our choices, the main benefit we are looking for is higher terminal prices than our initial costs.

There are many ways to attempt to achieve gains. In searching for good investments there is a false assumption that looking initially or only at past performance is the best means of accomplishing this goal. This presumes that the future will be very much like the past, which rarely happens. I utilize a holistic approach in examining not only the entire asset base, but also the potential risks to the individual capital owner.

For example, look at a university that is heavily dependent on government grants and contributions from science based workers. Working with the investment committee, they could decide that tech spending is cyclical and their capital should be invested contra-cyclically away from technology. With the very same set of conditions the investment committee, because of their own experiences, could decide that they are well versed in the issues and in the long run can tolerate this kind of volatility.

At this very moment, most stock and bond prices are flat to down this year, with principal gains in a handful of global tech stocks and their satellites. In these circumstances, a family with a combination of aging seniors and grandchildren entering college years could choose to optimize cash generation rather than aggressive capital appreciation, as they might have done in the past. Again, this is a particularly difficult time to make this judgement. Interest rates on high quality paper, while rising a bit recently, is absolutely lowering the value of fixed income because of the threat of rising global inflation. In addition, reinvestment risk on maturing investments is cyclically raised. The implementers of these decisions could benefit from discussions with their investment advisors, tax preparers, legal advisors, and family.       

Capital Preservation

Capital preservation is not the opposite of capital appreciation, but more like the other side of the coin. We all start with a bundle of talents, energy, and some money. We, over the lifetime of an individual, family, and institution, convert capital appreciation to beneficiary spending and interim investing. What is interesting is that during the investing period we are judged by investment performance, including the generation of cash. However, at the end of the period, and all periods end, we are judged by the aggregate size of the capital. All too often this is translated only as a sum of money. What should be included in this final assessment is what the expended capital has done in known and unknown people’s lives. (Read Andrew Carnegie’s views not necessarily his actions.)

What should we do now?

Any morning is a good time to change our future by making changes to our investment portfolio. I ask myself this question every weekend when I analyze the average investment performance of mutual funds as produced by my old firm, now part of Thomson Reuters. My conclusion is that at most one should consider tinkering with the mix of funds in specific portfolios, but not implement wholesale dramatic changes. The inputs to my thinking can be summarized as follows:

Year to date Average Investment Objective Performance
No matter what size, growth funds are up 2X value funds
World stock and bond funds are flat to down
High Quality Bond Funds are down more than their coupon
From David Rosenberg, at Gluskin Sheff since 2009, 13 million people are new to finance careers
The last bond bull market began 35 years ago

“You can see a lot by observing”  

A wonderful quote from Yogi Berra and something we attempt to think about when making only minor modifications to our various investment portfolios. My wife and I just returned from, in many ways our graduate school, The Mall at Short Hills on a drab and occasionally rainy Sunday of the Memorial Day weekend. This is a very upscale market place which had a good size crowd, but they carried relatively few shopping bags and were there with one or more other people. It seemed to me that in terms of their wardrobe and other shopping needs, they were tinkering at the periphery of their sartorial assets. If something at Amazon was priced right or had particular appeal they would buy and perhaps more than just one. (As usual, the Apple* store had the most people and a longer than usual line for specific appointments.) Many of these people are either direct investors or participants in salary savings plans, 401(K), 403 (b) and 457 plans.  Their shopping ode suggests to me that in terms of their financial assets, while they make tinker at the edges of their portfolio, they are not currently driven to make radical changes.
*Personally held in investment portfolios

The tinkering that I am suggesting to various portfolios is as follows:
In longer term equity portfolios look to good managers out of phase.
Longer term international funds and quite possibly selected emerging markets should be reviewed.
Sacrifice fixed income yield for shortened durations.
Plan for a busy fall and a difficult 2019-2020.

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Copyright © 2008 - 2018

A. Michael Lipper, CFA
All rights reserved

Contact author for limited redistribution permission.

Sunday, May 20, 2018

Chinese Disruption Around the World - Weekly Blog # 524


Most of those who think about the future of the Global economy believe that China at some point will probably replace the US as the global leader, until perhaps after a generation it is replaced with India. Based on current population trends,  Nigeria will have more mouths to feed in the future than India.

China Influences all Markets

Size, in and of itself does not guarantee a good place to invest. At this point investors, no matter what they invest in or where they invest, need to understand the ability of China to heavily influence, if not disrupt, almost all investing in stocks, bonds, commodities, real estate, art, and racehorses. While I intuitively agree with Charlie Munger that there are more investment opportunities in China than in the US, I lack sufficient confidence in my understanding as to how the winning game is played.  Nevertheless, I feel compelled to invest in China and Asia. The way I do it for my clients and myself is through selected Asian specialty funds.

The inclusion of some of the “A” shares in the MSCI indices is in response to demand from institutional investors to put money to work into China very quickly. There is more than the normal amount of risk being created, for the list of included stocks is based on size, not quality or other investment factors. This is particularly significant to what is likely to be a rash of China ETFs. When the financial reports become available there could be a positive fleshing out of how business is done in China.

Racetrack Influences

On Saturday the South China Morning Post, which is now essentially a vehicle for the Mainland government, published an entire section devoted to Horse Racing, with the kind of statistics we used to see in the US in the popular press and specific publications for racing fans. What is impressive to me is that the paper had extensive records of the leading jockeys and trainers. What is notable is that neither the leading jockeys nor trainers win over 20% of the time. This highlights my reluctance to embrace the most popular stocks most of the time.

The Chinese interest in both racing and more important breeding future champions, was again highlighted on a sloppy track Saturday afternoon when Justify won The Preakness. This is the second title to the Triple Crown after Justify won The Kentucky Derby for its largely Chinese syndicate owners. Competitors are labeling Justify as a “super horse.”

The newspaper has the same type of mutual fund price (NAV) listings one sees in London. These are paid placements which often represent the key profit item for the paper. Recently I co-chaired a panel at the International Stock Exchange Executives Emeritus conference in Hong Kong. In our lead off session with the Chair of Value Partners, I was somewhat surprised to see a good sized list of Value Partners funds and their classes in the newspaper. They even had some funds quoted in New Zealand’s currency. Most of their competitors are UK and Swiss groups. For historic and cultural reasons, only a few funds appear to be offered in the US.

Xi Jinping Cites People’s Liberation Army “Principles”

On Thursday the same paper had a front page article with a headline “President calls for stronger military science studies.” In the article Xi Jinping, as chairman of the Central Military Commission said, “Innovation has to be practical and closely based on warfare and combat issues to create advanced military doctrine suitable for modern warfare and embodying the PLA’s unique characteristics.” (Bear in mind the People’s Liberation Army has not been at war in a generation. During that period the US has almost constantly been in small wars.) Notice there is no particular emphasis on defense, which suggests offense is important and could be in the President’s plans.

The leading economic thinkers viewing China internally as well as externally are very conscious of developing economies running middle income growth to the limit. There is a fear that they become old before they become rich, as on balance China has an aging population. Japan and most of Europe  are laboring under demographics that reduce the proportion of productive human labor and an increase in the portion of the nation’s wealth spent on healthcare. (With US fertility rate at an all time low, we hope that US leaders see a similar long-term risks that needs to be addressed quickly.)

A number of funds investing in China have been shifting their emphasis away from exporters and basic industries, investing instead in consumer-oriented stocks and services. Many global and international portfolios cover their China bet with one or two stocks, such as Alibaba and/or Tencent. From a stock price standpoint, most of the time their prices parallel the so-called “FAANG” stocks, not China-focused developments.

Balance Sheets More Useful than  Income Statements

My old Securities Analysis professor David Dodd might have enjoyed my late conversion to paying initial attention to balance sheets rather than income statements. In the class (taught by the co-author of our text book) we had discussions on the proper methods of security analysis. I had the temerity to argue with him in favor of the primacy of income statement analysis. He shut me off once when we were discussing a specific security, which just happened to be in Graham and Dodd’s portfolios. He ended the discussion by informing the class and this doubter, how much money they had made on that position. Thus, it is ironic that I bring up balance sheet and related cash flow concerns in dealing with Chinese investments.

The very successful export drive that led to China being the fastest growing large economy for a number of years was based on exporting industrial goods and consumer products. On my visit to Hong Kong and Shenzhen* I was very impressed with the new infrastructure that has been put in place in under a generation. At the same time the US and most developed countries experienced deteriorating infrastructure, Hong Kong is expected to require an additional airport in 2019. (Our returning flight was slightly delayed in leaving as it had to coordinate with flights from nearby Chinese airports.)
*I would be happy to share by email the field notes of my visit to the fascinating BYD headquarters in Shenzhen.

China Experiencing Downsides to its Growth

However, there are a couple of downsides to the growth in the Chinese economy. After the farmers flocked to the cities, they used their savings to buy apartments, quickly followed by a cars, resulting in crowing and auto pollution. For this reason, the government is heavily subsidizing the production and sale of electric and hybrid cars. Thus China is the manufacturer of half of the world’s electric vehicles. This led to BYD leveraging its flows and balance sheet to a point where liabilities equaled or exceed assets. BYD is not worried however, as its loans are from state controlled banks.

One Belt, One Road Linkages

A further extension of debt was used to finance infrastructure in Africa and along the promoted “One Belt, One Road” connections from China to neighbors on the way to European markets, which will probably make use of the excess steel and cement capacity that is not being used internally in China. I am not predicting the future but rather asking prudent investors to study the history of debt-driven expansions in railroads in North and South America, and the financial history of the car business.

I will be happy to learn from subscribers about prudent ways to invest in China.
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